Apr 03 2007
Things you should know about Option ARM mortgages
I was talking to yet another victim of the infamous “Option ARM” mortgage. You know the mortgage that inevitably pops up as an in-your-face advertisement while shopping for home loan financing on the web. The ad usually reads; “Buy a home for $650,000 with a payment of only $1,672.53 per month”.Curiously I asked why they chose that particular type of mortgage program over all other home loan opportunities. The response remains; “I wanted a low rate and no one explained all of the terms associated with this loan”.Keep in mind the Option ARM mortgage loan allows homeowners the “option” of paying 4 different monthly payments. A typical 30 year amortized payment, a 15 year amortized payment, interest only payments, and of course the ridiculously low minimum payment. The low payment is based a rate as low as 1%. But is there a catch? There should be and there is…
The problem really isn’t just the program itself; it’s how banks and mortgage brokers are explaining the terms, or not. Everyone seems to be “selling” only the low payment! Homeowners will most certainly experience negative amortization and major payment adjustments down the road. Providing loan disclosures isn’t enough in this profession. We are responsible for making sure each and every client knows and understands the programs they are choosing prior to closing.
I have provided only 2 Florida homeowners the “Option ARM” over the past 11 years. Because when all the stipulations are explained, most home buyers or homeowners are no longer interested. Option ARM’s are for savvy mortgage investors only.
Here are some things new homeowners need to know when considering such a high risk mortgage.
· The actual rate of interest is the variable Index (which most of the time you were not told) and the fixed Margin (which can be as high as 3.45%). When you add the Index and the Margin you find the true interest rate.
· The higher your fixed Margin; the higher the lenders commission.· The actual rate is obviously higher than your very low payment rate. The difference between these 2 (rarely disclosed upfront) is debt you accumulate.
· If you pay the lowest allowed payment; the difference you owe is added on top of the principal. This is called negative amortization. Because you are only paying a payment rate, not the interest rate. Every day you owe more money than the day before and you also owe additional interest on that growing principal amount..· The prepayment penalties last as long as 3 years.
· The “Recast” feature. This never gets mentioned, but you sign the disclosure. Usually, once you have added 10% to your original loan amount, or 5 years have passed; the loan is set to recast. You realize you must now pay principal and interest payments based on the actual rate (The Index plus the Margin) at the remaining term. In other words, your payment increases dramatically.Option ARM’s are extremely high risk type mortgage programs suited for few home buyers or homeowners. This can only be realized when you are being informed, upfront, by a mortgage professional. Be informed and ask questions.